The global financial crisis has a negative effect on global economies. It was lead to a significant reduction in growth on economic. So I would conduct expansionary monetary and fiscal policies to stimulate macroeconomic, in order to evaluation the effects of policies I will analysis and discuss underlying economic model which is the Mundell-Fleming model under conditions of high but imperfect capital mobility and flexible exchange rates. In addition the current crisis also exposure the limitations of M-F Model to use macroeconomic policy, in the final part, I will make a conclusion discussing of the limitation of the theory.

The Macroeconomic theory behind macroeconomic policy

The IS-LM-BP model, sometimes referred as the “The Mundell-Fleming model” is an important parts of modern macroeconomic theory and useful vehicle for integrating the external and domestic sector in a full open-economy analysis. At this part I will introduce the Mundell-Fleming model under conditions of high-but-imperfect capital mobility and flexible exchange rates. This theory will help me to analysis and discuss effect of macroeconomic policy I have conducted.

When high-but-imperfect capital mobility under flexible exchange rate, the BP curve is not perfectly horizontal, but BP curve is flatter than the LM curve.

Monetary Policy: (Expansionary monetary policy)

Briefly summarized this would be:­

• LM curve shifts right, Y increases and R (real interest rate) decreases.
• Lower Real interest (i < iW) lead to reduces foreign capital inflows and increase capital outflow.
• Creates BP deficit and downward pressure on currency.
• Currency depreciation stimulates net exports (NX).
• Higher exports, lower imports.
• Both IS curve and BP curve shift right.
• Result is higher Y and lower R interest rate. (Efficiency policy)

1(Diagram 1)

A monetary expansion, shown on Diagram 1, expansion on money supply, the LM curve shifts to the right; the economy move from point A to point B. Y increases and R (real interest rate) decreases at the B, then the domestic interest will be lower than foreign interest (i < iW); a falling interest rate leads to more capital outflow and thus a fall in capital account (KA) and lead to deficit in the Balance of Payments (BP<0). BP<0 will lead to exchange rate is depreciating and increase in exports and a decrease in imports ,as a result of current account (CA) increased. A rising Aggregate Expenditure and Current Account bring about the IS and BP curves moving to the right side, these shifts are marked as (a) and (b). The new equilibrium (the point of C) is on the BP1 curve, where the economy has increased in Y1. Thus, this policy is efficiency and powerful policy that increases in the domestic money supply is to increase domestic output and decrease real interest rate which makes more competitively than foreign market.